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Financial Analysis, Planning and Forecasting Theory and Application. Chapter 15. Mergers: Theory and Evidence. By Alice C. Lee San Francisco State University John C. Lee J.P. Morgan Chase Cheng F. Lee Rutgers University. Outline. 15.1 Introduction
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Mergers: Theory and Evidence
Alice C. Lee
San Francisco State University
John C. Lee
J.P. Morgan Chase
Cheng F. Lee
Classification of business combinations
Methods of combination
Table 15.1 Largest Mergers, Acquisitions and LBOs: 1980-1995
Table 15.1 Largest Mergers, Acquisitions and LBOs: 1980-1995 (Cont’d)
Source: Mergers & Acquisitions, IDD Inc., Philadelphia, Reprinted with permission.
FIGURE 15.1 The relation between ER and P/E
Rjt = j + ßjRmt + jt (15.1)
Rjt = Rate-of-return on security j over period t,
Rmt = Rate-of-return on a value-weighted market index,
jt = Disturbance term with E(jt) = 0,
ßj = Measure of the systematic risk of security j, and
j = Intercept of the market model for security j.
TABLE 15.3 Selected companies that received offers in 1981
TABLE 15.3 Selected companies that received offers in 1981 (Cont’d)
On taxable acquisitions, the acquiring company’s tax basis in the stock or assets acquired is equal to the amount paid. For the selling firm, the entire gain (or loss) is recognized immediately and is taxable.
On nontaxable combinations, the seller defers recognition of the gain and the acquiring company obtains the seller’s basis for the stock or assets acquired.
Accounting treatment of business combinations
VAB = VA + VB,
Z = 0.012x1 + 0.014x2 + 0.033x3 + 0.006x4 + 0.99x5,
RIt - Rft = I + BI (Rmt - Rft) + EIt. (15.6)
Eit = CiEIt + it. (15.7)
Rit - Rft = i + ßi(Rmt - Rft) + it
= i + ßi(Rmt - Rft) + Ci(It - I) + it. (15.8)
Eit = i + it. (15.9)
In order to determine the hypothetical dividends and stock price, Shick and Jen use a common-stock valuation model (see Shick (1972) and Bower and Bower (1969)) based on Gordon’s model:
ln P = B0 + B1 ln D + B2 ln (gs/g1)
+ B3 ln g1 + B4 ln h
+ B5ln V + B6ln A + B7 ln F +
In this chapter, we have reviewed historical merger and acquisition activities in United States and other countries. Then, we have discussed accounting treatment of merger and acquisition. In addition, we also discussed the method to evaluate and forecast merger and acquisition activities.
There are many reasons why firms engage in business combinations and there is much we can learn from empirical research. Mergers and acquisitions provide a rich area for study of the firm because they allow specific events to be analyzed in light of their capital-market effects. An integration of accounting, microeconomics, and financial theory has the potential to provide a more complete theory of the firm.